I May Be a Credit Crunch "Denier" Too

As most of you already know, I am an anthropogenic global warming skeptic, aka “denier”. Well, a new paper by the Federal Reserve Bank of Minneapolis has turned me into a credit crunch skeptic too.

The maintstream narrative on why we need a bailout is that credit is “frozen”. We can’t just let the financial sector sort itself out because it provides the credit “grease” that lubricates the rest of the economy. The graphs in this paper make it pretty clear that the wheels of Main Street have plenty of grease. So it looks to me like the bailout is corporate welfare plain and simple. It also means that Paulson and Bernanke talking about how bad things are to justify the bailout may have actually exacerbated any real recession by magnifying the psychological salience of the crisis.

12 Responses

Since you are interested in complex systems, why not have a go at the monetary system we have. It has exponential growth built into it (interest) which is partly responsible for the ridiculous accumulation of wealth and debt over time. It also has short term thinking built into it, since every long term project which does not have a positive discounted cash flow is economical suicide.
These two flaws alone make this system ill suited to solve the problem we have. Wealth needs to be spread to avoid conflict and almost more importantly – to allow the good minds of this planet to have the time they need to come up with solutions to our problems, instead of fighting for survival.
I would be curious to hear your opinion about this matter.

Well, you asked for my opinion, so I’ll give it to you but you’re not going to like it.

I agree that “we” have problems. But “we” also have scarce resources. Moreover, “I” assign different priorities to the problems than “you”. So the trick is to figure out how to allocate resources to problems in a way that reflects these heterogeneous preferences.

The only proven way to do that is markets. Interest is simply a price for capital. We need this price to allocate capital.

And I think you have the wrong idea about positive discounted cash flow. It doesn’t encourage short term thinking. It actually encourages optimal accounting for time value preferences. That’s the “discounted” part. High time value preferences are not an artifact of our monetary system. It’s part of what we are as humans.

Bottom line: if you’re looking for a sympathetic ear to discuss a Utopian world without that pesky money thing, you’ve come to the wrong guy.

The interesting thing is that we’ve gotten to a point in history where it may not really be “up to us” whether markets exist. They now emerge very easily when there is both supply and demand. The question for policymakers at this point is if and how we can and should shape the markets so that their destructive aspects are mitigated.

But that’s not what efficiency means in this context. My statement is true even for an incredibly inefficient market.

In a voluntary economic system, you won’t make a trade that doesn’t make you better off. Neither will the person you want to trade with. So if a trade occurs, both parties must have wanted it and therefore are better off.

Market efficiency is a measure of what fraction of such theoretically beneficial trades get made. Let’s say there are a thousand potential trades that make both parties better off, but only 1 actually occurs (due to search costs, transaction costs, etc.). That market is only 0.1% efficient.

But for every trade that did occur, both parties were better off. No utopia here. Just the heterogeneity of endowments and preferences making the world go round.

In a voluntary economic system, I will not make a trade that I don’t *think* makes me better off (and neither will you.) But does this make it so? We are not always trading wheat for sugar. What happens when you sell me a condo that I can’t afford to make payments on, or perhaps you cannot afford to finish building.

I understand you are referring to the “theoretical” but I think Rafe’s comment above is in reference to the “real world”. Did the real estate market not lead to many bad trades being made?

To Daniel’s point, I’ve been involved in fantasy sports leagues in which trades don’t happen even when they should (when both parties would be better off). Granted these are small examples, and perhaps when scaled, deadlock gets broken, but I tend to agree with Daniel that trades don’t automatically happen just because they are better for both parties than not trading.

Actually Rafe, Daniel’s point is different from yours. Yours is about lack of efficiency: trades that should happen don’t. Daniels is about trades that shouldn’t happen that do.

In you case Rafe, the market isn’t doing any harm. It just isn’t doing as much good as it could. So what? That just means there’s an opportunity for an entrepreneur to come in and make the market more efficient. The market isn’t harmful in any way.

Daniel has raised what turns out to be a deep philosophical issue. My take is that every trade makes everybody better off at the time it occurs. Of course, just like any other resource allocation problem, circumstances may change that make it bad in retrospect but never in prospect. You can always experience a bad outcome. But again, this isn’t the market’s fault.

I should note that wheat can spoil so the analogy that real estate markets are somehow fundamentally different is flawed.

The philosophical issue is people’s ability to deal with uncertainty. Basically, human’s aren’t particularly good at it so you can argue that you should protect them from making mistakes. But the market actually makes this better because a market prices risk better than any individual, even an individual expert.

I’m all for disclosure laws that help people see risks. But you need the market to price that risk at all effectively.

Free markets are necessary, but not sufficient. There is a reason why collusion and monopolies are shunned and leverage is limited (at times).

WHEN and IF the playing field is level and you’re trading baseball cards, everyone is better off. Obviously (in poker), the size of the stack matters and one can bluff their way to winning, which isn’t a FAIR resource allocation by a long shot even if it makes for a fun game of politics if anything. Fair is a utopian idea, but the idea of capitalism is also utopian. Self-interest without any controls cannot lead to best resource allocation for the group. it leads to accumulation of resources by the group that played the path of history correctly. Someone with a fresh stack of chips could overthrow the king, but what if the king can pay chips to change the rules and prevent competition? We DO need rules, so then i pose the question to you – what should they be?

Leverage is an issue because we make mistakes and we cannot risk the entire system this way. Some leverage is fine. I don’t need or want to argue the strong version of this case. If the system wasn’t leverage to the tilt or have an apperance of such, then any mistake, even in the banking sector, wouldn’t lead to a systemic risk and wouldn’t need bailing out. Dotcoms/Tech certainly didn’t (right?).

SO, yes complex markets ought to be applied to economics and finance. I also agree that letting the system FAIL is the only way to keep everyone fair and Bernanke/Paulson engaged in yet another instances of defrauding capitalism of its ideals and taxpayers/savers of their correct choices.

A straw-man (but interesting) alternative to disallowing leverage is to stipulate the following. Anything is allowed as long as the cash amount that is being loaned is delivered in USD (or EUR) and is delivered in person from the lender to the borrower, face to face, along with the signed contract and the handshake.